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Monetary policies and inflation targeting in emerging economies

Several emerging-market economies have adopted inflation targeting as their institutional framework for conducting monetary policy. This volume focuses on the experiences of Brazil, Chile, Czech Republic, Indonesia, South Africa, and Turkey.

Luiz de Mello and Diego Moccero use a conventional New Keynesian model to empirically test whether adoption of IT in a flexible exchange rate regime after 1999 has affected macroeconomic volatility in four Latin American countries (Brazil, Chile, Mexico and Colombia). The authors show that these monetary policy regime changes have been accompanied by lower volatility in the monetary stance in Brazil, Colombia and Mexico, despite higher inflation volatility in Brazil and Colombia. They also show that the post 1999 regime has been associated with greater responsiveness by the monetary authority to changes in expected inflation in Brazil and Chile, while in Colombia and Mexico monetary policy has become less counter cyclical. Also, lower interest rate volatility in the post 1999 period was found to owe more to a benign economic environment than to a change in the policy setting itself. Finally, the change in the monetary regime has not yet resulted in a reduction in output volatility in these countries.

Chapter 2: Brazil: Taming inflation expectations

Afonso Bevilaqua, Mário Mesquita and André Minella discuss the conduct of monetary policy in Brazil. The authors assess the convergence of inflation and inflation expectations to the targets after the confidence crisis of 2002. The analysis covers the ensuing disinflation period and economic recovery, as well as the consolidation of disinflation in 2005 06. It is argued that the conduct of monetary policy and the overall improvement in macroeconomic fundamentals have contributed to creating a more stable, predictable macroeconomic environment, evidenced by a reduction in inflation uncertainty. Furthermore, the econometric analysis reported in the chapter underscores the critical role played by the inflation targets as “attractors” for expectations.

The Chilean experience with IT is discussed by Rodrigo Valdés. He focuses on the last sixteen years and highlights a number of institutional characteristics of the Chilean IT regime that have contributed to, or acted as a pre requisite for, a good track record of inflation control. The chapter also sheds light on particular macroeconomic outcomes, including changes in the dynamics of inflation, as well as on selected practical issues in the conduct of monetary policymaking under IT, including the role of inflation expectations and the exchange rate.

Chapter 4: The Czech Republic’s inflation targeting experience

The experience of the Czech Republic with IT – the first one in a transition economy – is discussed by Kateřina Šmídková. She argues that IT was adopted only after other monetary policy regimes had failed. An important feature of the Czech regime is the need to build an exit strategy into the policy framework, given the country’s expected entry into the euro zone, although no date has yet been announced. The problem of exiting from a monetary policy regime has so far been faced by countries with fixed exchange rate regimes (including currency boards), rather than IT.

Chapter 5: Monetary policy in emerging markets: The case of Indonesia

Hartadi Sarwono discusses the Indonesian experience. He emphasises rapid structural changes in post crisis Indonesia as an important feature of the country’s monetary regime. The need to deal with fiscal dominance and relatively shallow financial markets are additional important challenges for the monetary authorities, especially against a backdrop of exchange rate volatility and sudden shifts in capital inflows. The author argues that, due to these characteristics of the Indonesian regime, policy co ordination between the monetary authorities and the government at large needs to be enhanced. This co ordination is particularly important to minimise the inflationary pressures associated with a large share of administered prices (which are set by the government) in the consumer price index and volatile food prices.

The South African experience is discussed by Monde Mnyande. He describes the institutional underpinnings of monetary policymaking in South Africa, including the instruments that have been put in place since introduction of IT to strengthen the central bank’s communication with market participants and the public in general. On discussing the main features of the South African regime, he contends that monetary policy has become more forward looking following the introduction of IT.

Gülbin Şahinbeyoğlu discusses the case of Turkey. She explains how the country’s monetary policy regime was changed in response to the collapse of the exchange rate peg in 2001 and how inflation targeting was adopted. She discusses how the preconditions for formal IT were fulfilled, and how these achievements helped to lower inflation at single digits. The move to formal IT in 2006, as well as the institutional changes it entailed, is also discussed in the chapter, as well as the successes and challenges the monetary authorities were confronted with within this new policy regime. The chapter concludes with an assessment of the lessons to be drawn from Turkey’s experience with IT.

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